If you been in business for any length of time you have heard the term KPI – Key Performance Indicator.
But exactly what is a KPI, and why do they matter?
Investopedia defines a KPI as: a set of quantifiable measures that a company uses to gauge its performance over time.
You can have many different types of KPI’s that you track; financial, marketing, and quality metrics are just a few examples.
I like what Klipfolio, an app for creating dashboard, reports and visual analysis contends makes for effective KPI’s – a KPI is only as valuable as the action it inspires.
In other words, all the data in the world doesn’t do any good by just sitting there looking pretty, you need to know what it is telling you and by extension, what you need to do about it.
There are 5 KPI’s I have adopted and call “Healthy Business KPI’s”.
- Profit Allocation %
- Owners Market Based Wage Target
- Tax Allocation %
- Labor Productivity Rate
- Total Debt
Each of these KPI’s has a goal attached to it, and we track monthly progress toward goal, and review and adjust goal as necessary. Note also that each KPI corresponds to a Profit First Core Account.
Here is a brief overview of each and how they align with the Profit First cash management model:
KPI 1: Profit Allocation % (Profit Account)
This KPI is as simple as it sounds. How much are we allocating into the Profit account?
KPI 2: Owners Market Based Wage (MBW) Target (Owner’s Pay Account)
Read this article for a discussion on MBW and why it matters. This KPI is tracked as a % of how much the owner(s) is actually paying themself compared to their Market Based Wage.
KPI 3: Tax Allocation % (Tax Account)
Again very simple. How much is being allocated into the Tax account? Don’t be fooled into thinking lower is better. As Greg Crabtree says in his book “Simple Numbers, Straight Talk, Big Profits”, if you aren’t paying taxes you are either not making any money or you are cheating. Take advantage of every legal and smart way to minimize your taxes, but understand that successful companies are going to pay taxes. The more you are paying, the more you are making. And that’s a good thing.
KPI 4: Labor Productivity Rate (Operating Expense Account)
This KPI tells you how much Gross Profit you are making for every dollar of labor you are spending. As payroll is most likely your biggest expense, you need to be tracking this number carefully. This KPI can be used in forecasting what effect additional employees will have on your bottom line and what productivity (eg. more dollars earned) will need to be reached to regain your target Profits. An important note: we always calculate this two ways; actual Labor Productivity Rate (LPR) and TrueLPR.
True LPR is the rate when the owner(s) Market Based Wage is added in, which is a critical difference.
Here’s an example:
In April company X had $25000 in Gross Profit and $12,500 in Total Labor Cost. In this case their Labor Productivity Rate is $2.00 ($25,000 Gross Profit/$12,500 Total Labor Cost). But this doesn’t take into account the owner is paying herself $5000/mo, while her Market Based Wage is actually $7500/mo. To get the True LPR, we need to add the additional $2500 to the Total Labor Cost, which gives a True LPR of $1.66 ($25,000/$15,000). Ok, I’ll stop with the acronyms already! In chart form it looks like this:
Why does this matter? Read this article, “Stealing From Yourself” for more detailed insight.
KPI 5: Total Debt (Operating Expense Account)
Debt reduces profitability, creates higher risk in an economic downturn, and less flexibility to direct your cash when opportunity arises. The unfortunate truth is many of the business owners I talk to know this, but do not have a system to pay it down. It starts with calculating and tracking your total debt load. You have to stop paying expenses with debt, and live within your means. The goal is to have this KPI as ZERO!
We keep these “Healthy Business KPI’s” all in one place on a scorecard. At a glance we can detect patterns and trends, and take appropriate action when one is off track. The beauty is they all work together, so usually taking action on one effects the others positively as well. For instance a strategy to pay debt off more quickly will free up cash to get me to my Market Based Wage, which in turn makes my business more valuable to investors and/or buyers.
If all these numbers make your head spin, I get it. But I promise this is not as hard or time consuming as it looks. A few key pieces of data entered on a monthly basis will make these KPI’s you can truly profit from. We can show you how.